Widening the band

The widening of the daily trading band for the yuan against the dollar from 0.5 to 1 per cent is a sign of confidence on the part of the Chinese authorities and reflects their belief that the currency is no longer undervalued. It will give the People’s Bank of China more room to test the monetary waters and should improve long-term stability. This increase is notably bigger than the last one from 0.3 to 0.5 per cent in 2007.

The greater flexibility of the yuan will be of some help in fighting inflation though food prices remain the main component in CPI rises and the currency has relatively little effect on them. Only the Japanese yen and Indonesian rupiah have performed worse than the yuan against the dollar this year but the steady state of the Chinese currency is notable, as shown in the charts below. Its movement will be dictated primarily by domestic concerns until Beijing has made up its mind as to the extent of the threat of sluggish external demand to exporters.

Chart 1: Currency performance, 16 January – 13 April 2012 (vs US$, three-day moving average)

Chart 2: Currency performance, 15 April 2011 – 13 April 2012 (vs US$, three-day moving average)

The move should be seen in a political context of forthcoming IMF meetings and the US move into the Obama-Romney fight for the White House. The Republican has committed to declaring China a currency manipulator on his first day in office. Is Beijing now trying to give him wiggle room to get off that particular hook? That said, we do not expect any big movement in the yuan against the dollar at least until the outlook for the second half in China is clearer.

The data for the first quarter were mixed, with the growth figure above consensus at 8.1 per cent (my colleague Bo Zhuang had predicted 8.2 per cent against consensus of 6.4 per cent). Different PMIs pointed in different directions. The latest industrial production number was reassuring and retail sales held up well while the higher loan number was due in part to the end-of-quarter effect. But Mainland steel mills, which account for half the world's output, declared losses of Rmb2.8 billion yuan ($444 million) in the first two months of this year, Chinese media reported today.

While we remain outside the hard landing school, we expect a soft patch in the second quarter before an upturn in the second half, with a decline in starts on real estate projects pulling down the overall numbers as restrictions on property stay in place until the government is sure it has a proper handle on the sector.